Many indicators and calculations are used to assess the value and growth potential of a stock. Here are some key indicators used by investors.
1. Earnings per share (EPS)
This is the amount each share would get if a company paid out all of its profit to its shareholders. EPS is calculated by dividing the company’s total profit by the number of shares.
Example – If a company’s profit is $200 million and there are 10 million shares, the EPS is $20.
EPS can tell you how companies in the same industry compare. Companies that show steady, consistent earnings growth, year after year, will often outperform companies with volatile earnings over time.
2. Price to earnings (P/E) ratio
This measures the relationship between the earnings of a company and its stock price. It's calculated by dividing the current price per share of a company's stock by the company's earnings per share.
Example – A company's stock currently sells for $50 per share and its earnings per share are $5. That means it has a P/E ratio of 10 ($50 divided by $5).
The P/E ratio can tell you whether a stock’s price is high, or low, compared to its earnings.
Some investors consider a company with a high P/E to be overpriced. But sometimes a company with a high P/E today may offer higher returns, and a better P/E, in the future. How do you know? You’ll likely have to look at other indicators before you decide.
3. Price to earnings ratio to growth ratio (PEG)
This helps you understand the P/E ratio a little better. It’s calculated by dividing the P/E ratio by the company’s projected growth in earnings.
Example – A stock with a P/E of 30 and projected earnings growth next year of 15% would have a PEG of 2 (30 divided by 15). A stock with a P/E of 30 but projected earnings growth of 30% will have PEG of 1 (30 divided by 30).
The PEG can tell you whether a stock may or may not be a good value. The lower the number, the less you have to pay to get in on the company’s expected future earnings growth.
4. Price to book value ratio (P/B)
This compares the value the market puts on a company with the value the company has stated in its financial books. It's calculated by dividing the current price per share by the book value per share. The book value is the current equity of a company, as listed in the annual report.
Most of the time, the lower the P/B is, the better. That's because you're paying less for more book value.
If you're looking for a well-priced stock with reasonable growth potential, you may want to use a low P/B as a tool to identify possible stock picks.
5. Dividend payout ratio (DPR)
This measures what a company pays out to investors in dividends compared to what the stock is earning. It's calculated by dividing the annual dividends per share by the EPS.
Example – If a company paid out $1 per share in dividends and had an EPS of $3, the DPR would be 33% (1 divided by 3).
The DPR can give you an idea of how well a company’s earnings support the dividend payments. More mature companies will typically have a higher DPR. They believe that paying more in dividends is the best use of their profits for the firm and its shareholders. Since growing companies are likely to have less or no earnings to pay out dividends, their DPR would tend to be low or zero.
6. Dividend yield
This measures the return on a dividend as a percentage of the stock price. It's calculated by dividing the annual dividend per share by the price per share.
Example – 2 stocks each pay an annual dividend of $1 per share. Company A's stock is trading at $40 a share, but Company B's stock is trading at $20 a share. Company A has a dividend yield of 2.5% (1 divided by 40), while Company B’s is 5% (1 divided by 20).
The dividend yield can tell you how much cash flow you're getting for your money, all other things being equal.
Content in this section is provided in partnership with Investor Education Fund, a non-profit organization founded and supported by the Ontario Securities Commission that provides unbiased and independent financial tools to help Canadians make better money decisions. To find out more, go to: GetSmarterAboutMoney.ca